SEC Amends Disclosure Rules for Acquisitions and Disposals of Businesses

The Securities and Exchange Commission today announced changes to the disclosure requirements of Regulation S-X related to the acquisition or disposition of a business, which are intended to reduce the complexity and compliance costs of the disclosures.  The changes include updates to the definition of a “significant subsidiary” and changes to the tests of significance in Rule 1-02(w), Securities Act Rule 405 and Exchange Act Rule 12b-2. The tests of significance are used to determine how many years of audited financial statements and unaudited periods of financial information are required to be included with a registrant’s filings. Rule 3-5 of Regulation S-X discusses the audited and unaudited financial statement requirements for a registrant.  Those requirements are dependent upon the level of significance of the acquisition or disposition to the registrant based on the results of the tests of significance.  In addition to the audited financial statements and unaudited financial statements of an acquisition, pro forma financial information may also be required to reflect the historical results of the registrant adjusted to reflect the acquisition or disposition of a significant business.

As noted in the SEC’s press release, the final changes will, among other things:

• update the significance tests in Rule 1-02(w), Securities Act Rule 405, and Exchange Act Rule 12b-2 by:
  • revising the investment test to compare the registrant’s investments in and advances to the acquired or disposed business to the registrant’s aggregate worldwide market value if available;
  • revising the income test by adding a revenue component;
  • expanding the use of pro forma financial information in measuring significance; and
  • conforming, to the extent applicable, the significance threshold and tests for disposed businesses to those used for acquired businesses;
• modify and enhance the required disclosure for the aggregate effect of acquisitions for which financial statements are not required or are not yet required by eliminating historical financial statements for insignificant businesses and expanding the pro forma financial information to depict the aggregate effect in all material respects;
• require the financial statements of the acquired business to cover no more than the two most recent fiscal years;
• permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity; permit the use of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board in certain circumstances;
• no longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance;
• align Rule 3-14 with Rule 3-05 where no unique industry considerations exist;
• clarify the application of Rule 3-14 regarding:
  • the determination of significance;
  • the need for interim income statements;
  • special provisions for blind pool offerings; 
  • the scope of the rule’s requirements;
• amend the pro forma financial information requirements to improve the content and relevance of such information; more specifically, the revised pro forma adjustment criteria will provide for:
  • “transaction accounting Adjustments” reflecting only the application of required accounting to the transaction;
  • “autonomous entity adjustments” reflecting the operations and financial position of the registrant as an autonomous entity if the registrant was previously part of another entity; and
  • optional “management’s adjustments” depicting synergies and dis-synergies of the acquisitions and dispositions for which pro forma effect is being given if, in management’s opinion, such adjustments would enhance an understanding of the pro forma effects of the transaction and certain conditions related to the basis and the form of presentation are met;
• make corresponding changes to the smaller reporting company requirements in Article 8 of Regulation S-X, which will also apply to issuers relying on Regulation A;
• amend the definition of “significant subsidiary” to provide a definition that is specifically tailored for investment companies;
• and add new Rule 6-11 and amend Form N-14 to cover financial reporting for fund acquisitions by investment companies and business development companies.

These amendments are effective on January 1, 2021 but voluntary compliance will be permitted before the effective date. For questions on interpretation and application of these changes, you should reach out to your trusted professional advisors for consultation and guidance.